(Reuters) – A major lender to China’s Suntech Power Holdings, a solar panel maker which has been stung by a $690 million fraud linked to its expansion in Italy, financed the expansion despite warnings from a business ally to avoid Italy’s scam-ridden solar sector.

U.S.-listed Suntech (STP.N), the world’s largest supplier of solar panels, has lost 40 percent of its market value since revealing on July 30 that 560 million euros ($691 million) in bonds involved in securing the bank financing may never have existed.

Suntech has declined to discuss how the German government bonds in its possession turned out to be apparent forgeries and has hired lawyers to investigate one of the biggest suspected frauds to hit a listed Chinese company.

Sino-Italian private equity firm Mandarin Capital Partners said it wrote emails to the China Development Bank (CDB) as early as three years ago, advising it not to get involved in Suntech’s target area of southern Italy, partly because fraudsters in the booming renewable energy industry there had become a major risk. Reuters has seen one of the emails.

Mandarin Capital said it was invited in 2009 by CDB, which was also an investment partner of Mandarin Capital in other ventures, to co-invest in Suntech’s Global Solar Fund (GSF), an investment vehicle spearheading the Italy expansion as a way of creating demand for Suntech’s panels.

Mandarin Capital said it turned down the approach and also wrote to CDB, a major policy bank that lends at the behest of China’s government, advising it not to help finance the fund’s Italian projects because they were too large to be viable and carried the added risk of possible encounters with criminals.

State-run CDB went ahead and lent 554 million euros to one of the GSF fund’s investee firms, Solar Puglia II. Puglia is a southern Italian region where solar investment has boomed. It is unclear if the bank passed on the warning to Suntech, or whether CDB had been given contrary advice or had already been obliged to make the loan before Mandarin’s warning.

But the revelation raises questions over how the strong advice of an experienced Italian investor went unheeded, and also how Suntech could then fall victim to a fraud that lawyers said would not have survived basic due diligence.

Suntech and CDB declined to comment for this article.

The Chinese bank’s willingness to go ahead despite the risks also underlines complaints by foreign competitors that easily accessible and often-cheap state funding offers Chinese firms an unfair advantage and can lead to weak corporate governance. The terms of the CDB loan are not spelt out in Suntech filings.

“GSF smacked of a scam,” said Alberto Forchielli, managing partner of Mandarin Capital, a private equity fund set up in 2007 to mainly facilitate outbound Chinese investment. CDB is a key investor in the Mandarin fund, along with Export-Import Bank of China and Italian bank Intesa Sanpaolo (ISP.MI). “But CDB didn’t listen to me.”

Forchielli said CDB had approached him to invest in the fund, mostly for solar power plants in Puglia and Sicily. In an email seen by Reuters and sent to a CDB official in June 2010, he described Italy as a “solar bubble” and said Chinese investors were not best placed to invest there.

“We got suspicious because it did mention a lot of important corporate, banking, legal names associated to the project, a tactic usually adopted by fraudsters in my experience,” he said.

He added he also sought advice from the head of an affiliated Italian firm, Cleantech S.r.l., before counselling CDB against financing the Italian projects. Unlike Mandarin Capital, Cleantech specializes in renewable energy and its chief executive, Stefano Carpigiani, told Reuters he had confirmed to Forchielli that the venture was unwise.

MURKY TRANSACTIONS

The suspected fraud revealed last week follows the discovery of documentation “inconsistencies” with the German bonds, which were held by Suntech as a hedge in case CDB ever called in Suntech’s commitment to guarantee the 554 million euro loan.

In a conference call on July 30, Suntech also accused the GSF fund’s outside manager, Spaniard Javier Romero, of possible fraud, but it gave no evidence and did not take questions.

Suntech owns 80 percent of the fund and provides several managers to oversee the work of Romero, whose own private firm, GSF Capital Pte Ltd, holds 10 percent. Suntech Chairman Zhengrong Shi, one of the Suntech managers who supervised the work of Romero, also owns 10 percent. Shi declined at the July 30 Suntech briefing to answer any questions.

Romero could not be reached for comment, but Italian public relations firm Allea, which represents GSF in Italy, emailed what it said was a statement on his behalf denying wrongdoing.

“GSF Capital Pte Ltd and Mr Romero are investigating alleged irregularities in relation to the bond pledge,” it said. “They deny any wrongdoings, will contest any proceedings against them, and are confident they will be exonerated by the process.”

Italy’s solar market has become the world’s second-biggest after Germany, thanks to generous government incentives in place since 2007, and it was the world’s fastest growing in 2011.

Puglia, Sicily and other parts of southern Italy are blessed with Mediterranean sunshine and cheap land, making them natural destinations for solar power investors looking to profit from the rich incentives for renewable energy.

The boom has led to a series of well-publicized arrests for corruption and also asset seizures in recent years in southern Italy, in both wind farms and solar power, as government incentives are due to be scaled back. Italian crime-fighters have also enlisted the help of anti-mafia investigators in operations targeting the sector in the country’s south.

This year, “Operazione Eclisse” ended in the seizure of 10 solar plants in Brindisi, a province in Puglia, after local authorities became overwhelmed by fraudulent requests for fast-track permit approvals – scams designed to get projects approved quickly to take advantage of the incentives.

“The fraudulent procedure is the same – to split up artificially a single plant to get round procedures envisaged by the law,” deputy prosecutor for the Brindisi area Nicolangelo Ghizzardi said earlier this year on local Web TV TeleBrindisi.

There is no suggestion that organized crime was involved in the suspected fraud on Suntech, though the company has given only sketchy details of the transactions that led to it.

PAPER CHASE

Suntech said it had obtained the German bonds from Romero’s private firm, GSF Capital. It said it needed the paper as security because it had guaranteed CDB’s loan to Solar Puglia II. If the loan soured and Suntech was forced to pay up, Suntech could do so by selling the bonds and using the proceeds.

But the bonds did not ultimately belong to Romero, according to Suntech, which revealed on July 30 that Romero’s firm had actually borrowed the paper from another, unnamed European company. Suntech has not disclosed the name of the fictitious bonds’ original owner, nor said why it relied on Romero for this sum of paper and not the GSF fund’s own assets.

It is also unclear what, if anything, Suntech paid Romero in return for him pledging the bonds to Suntech, or how much Romero’s firm was paying the paper’s mysterious European owner for the right to hold them and pledge them to Suntech.

“We fail to understand why a European company would allow GSF Capital to borrow 560 million euros in bond paper, as GSF Capital’s asset base is less than 10 percent of the value of the bonds,” Daiwa Securities analyst Pranab Kumar Sarmah said.

Another mystery is why it took Suntech two years after guaranteeing the CDB loan to discover they may not exist.

Suntech said the bond certificates had been deposited in a custodian bank and the fraud only came to light recently when Suntech decided to sell out of the fund and its lawyers began checking the fund’s affairs.

“The company could have taken some pretty basic due diligence steps to make sure the bonds are there,” said Roger Lui, a corporate lawyer at Allen & Overy in Hong Kong, who is not involved in the Suntech case.

The case reads like a detective story, amazing deals of this Spaniard and how he managed to sneak by his fake German bonds; it is yet another case of financial trickery in this last sorry quinquenium. Still there are lighthouses to point the way in the dark swirling oceans of lies and deceit, these current times of Leviathan.

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About Alberto

Alberto Forchielli, born in 1955, received an MBA with honors from Harvard Business School and a bachelor’s cum laude in Economics from the University of Bologna. He is a founding partner of Mandarin Capital Partners, and the founder and president of Osservatorio Asia, a non-profit research center focused on Asia. He is also the founder of T-Island, a consultancy agency specialized in international relocations for professionals. In addition, he guided the expansion of the Roland Berger Foundation to Italy, which provides individual support for talented students lacking means to further their educations.